The
International Monetary Fund has warned the Philippine government that one of
the risks the economy faces is a “domestic asset price bubble”, which could
burst, weaken its financial sector, and slow down economic growth. The IMF made
this assessment in its “Country Report No. 12/102”, or its staff report for the
2013 Article IV Consultation with the Philippine government.

It reported:
“The Philippines’ stock exchange index rose 33 percent in 2012 and a further 8
percent during January 2013, with bank share prices jumping 59 percent in 2012.
Nominal prices of high﷓end residential properties have also
been buoyant, rising 8 percent year﷓on﷓year, with rents increasing more than
15 percent.”

The IMF data
showed that the year-on-year increases in Philippine property prices (proxied
by Makati prices) starting 2011 have been higher than those for Indonesia and
Singapore, but a bit lower than those for Malaysia. (See chart)

The IMF
pointed out that banks’ exposure to real estate has rapidly expanded, and their
loans to this industry may not be reflected in their reports to the BSP.

It therefore
recommended to the Bangko Sentral ng Pilipinas to monitor not only banks’
credits loans for property acquisition and to property developers but also its
credits to thrift banks, which in turn use these funds for the industry.

The IMF
report disclosed that the inter-agency committee called the Financial Sector
Forum—consisting of the BSP, the Securities and Exchange Commission, the
Insurance Commission, and the Philippine Deposit Insurance Corp.—have started
“to gather information on all sources of real estate finance”, which should be
accelerated and widened.

The IMF
warned “real estate developers may (have been applying) less-stringent lending
standards and more-generous loan terms than required of banks, including (a
higher cap than the standard 60 percent loan-to-value) and by offering initial
teaser terms.” The IMF staff claimed “some banks may not also be in full
compliance with the loan-to-value limits.”

The IMF
explained one possible weakness of the real-estate market by pointing out that
“about 80 percent of new residential construction (by number of units) is in
the low middle price bracket. Of these, about half are reported to be purchased
pre construction by overseas foreign workers.” The risk here, the IMF implied,
is the “possible non-renewal of OFWs’ short-term employment contracts”, which
could make the real-estate projects unviable.

What is
worrying, the IMF noted, is that “no institution has oversight responsibility
for the housing sector from a macro-financial perspective.” It explained that
such responsibility is not that of the Housing and Land Use Regulatory Board,
which merely regulates construction standards and licensing real estate
projects.

The IMF here
was drawing from the experience of the real-estate meltdown in 2008 in the US,
caused by real estate mortgages gone wild, which expanded into an untenable
bubble, but were hidden because of complex financial instruments until it was
too late.

In its Risk
Assessment Matrix, the IMF staff outlined how the real-estate bubble could
burst and torpedo the country’s long-term economic situation.

The IMF explained
how a short rapid growth could lead to a long-term stagnation: “Overly rapid
credit expansion, coupled with intensified real estate activity and stretched
asset prices—possibly driven by a capital inflow surge—could accelerate GDP
growth in the near term. However, a subsequent unwinding would likely have
large negative macroeconomic effects over the longer run.”

To prevent
the property bubble from emerging, the IMF staff recommended the tightening of
regulations on banks’ exposure to property especially with regards to the
interpretation of the 20 percent limit on their loans to the real estate
industry.

The IMF
emphasized: “Prudent loan origination standards and existing regulations should
be strongly enforced, supported by a comprehensive positive credit registry,
conservative debt to income guidelines for retail borrowers, and granting an
explicit legal mandate to an appropriate institution for stability aspects
related to the real-estate sector.”

An emerging
property bubble was one of five risks to the Philippine economy the IMF staff
report outlined. The other four are as follows:

• “Default by
a highly-leveraged conglomerate” (discussed in this column last Monday);